For many investors, even the intelligent and well-informed readers of Cabot Wealth Advisory, the biggest decision to be made in their portfolio is whether to put your money into index funds or to make the jump to actively managed funds.

Yes, active management is a bit more expensive (in terms of management fees), but if you want to achieve that ultimate goal of the ambitious investor—beating the index!—you have to pay for the privilege.

But do you know what you actually get if you select an actively managed mutual fund? Do you have any idea how “active” the management really is?

Let me tell you.

Actively managed funds are always structured to include a benchmark, an index that is used to gauge the success of the fund for the quarter, the year, and five- and 10-year periods. Beating the index consistently seems like it ought to be the fund manager’s ticket to success, but there’s a hidden agenda at work: Nobody wants to beat the index by too much.

That’s because the successful manager actually has two goals. The most obvious one is to beat the index. But the second is to outperform all the other managers in his assigned class, whether it’s large-cap growth stocks or small-cap value issues. And that outperformance will make a manager’s fund attractive to investing whales like pension funds. And that’s where the real money is.

Finishing in the bottom half of your peer group isn’t a good thing, of course. But ending a year with performance in the top quarter of your peers is also suspect. In order to rank in the top quartile, you have to take on too much risk, which raises the spectre of finishing in the bottom quartile next year. (That’s really how the mutual fund industry thinks. I swear.)

Any manager who can bring his fund in with second-quartile performance year after year, will soon be looking for a bigger boat or wearing a rarer wristwatch.

But what about the poor individual investor who’s paying the extra bucks to beat the index?

That investor’s needs finish far behind the manager’s need to calibrate his performance to hit the sweet spot against all those other funds in his group. Even performance versus the index, which is supposedly what active management is all about, is less important to the institutional investors who have billions to allocate.

Believe me, if a fund manager can beat his peer group, his actual outperformance of the index is just an afterthought.

So, how does a manager contrive to outdistance his competitors by a decent—but not excessive—amount?

The first thing he does is to set up a portfolio that mirrors the relevant index, stock by stock and weight by weight. That’s why a stock that gets added to an index will often experience a surge in buying as managers who use that index as a benchmark adjust their holdings to match its weight in the index.

And then the tweaking begins. Maybe a manager’s research points to a slight decline in desktop computer sales during the next year. So he shaves off a small portion of his exposure (relative to the benchmark) to a parts supplier or a retail outlet that sells desktops. Or maybe a visit to a railroad company shows such a successful outlook for haulage that the manager returns to his headquarters and buys a bit more of a supplier of train cars until he has a slightly overweight position.

And in exceptional cases, the manager may even decide not to own a stock or two in the index or to buy a company that’s not in the index. Bold moves indeed!

Remember, however, that the manager isn’t trying to maximize gains! He’s shooting for outperforming half of his peer group and underperforming a quarter of them.

So when anyone asks me whether it’s worth it to diversify their portfolios using actively managed mutual funds, all I want to say is, “If that’s the most ambitious move you can think of, I think you’re selling yourself (and your portfolio) way too short. “

You don’t have to swing for the fences to knock in a heck of a lot more runs than any actively managed portfolio. With one foot tied to an index and one eye constantly watching what peer funds are up to, active managers are not out to make you real money. In fact, they can lose money and be quite proud of themselves if they have reached their twin goals: 1) Beat index. 2) Beat rivals (but not by too much).

Cabot growth advisories don’t give much of a rip about performance versus an index. The only use we make of indexes is to tell us when the trend of the market is up (in which case we move aggressively to identify and invest in the leaders) and when the trend is down (when we cut back on buying and move more cash toward the sidelines).

The person who cares the most about the absolute performance of your portfolio is you. And Cabot has almost 45 years of advising individuals like you about what stocks to buy, when to sell and how to get in sync with what the market’s doing.

If you want active management of your portfolio, Cabot can be the active partner you need to target real gains.

A High-Flying Mexican Stock

With most Chinese stocks under heavy pressure from the general downtrend of the Chinese market, my stock pick today is a Mexican airline that’s prospering as more and more local travelers opt for the comfort of air travel over the vagaries of buses or trains.

The company is Volaris (VLRS), and while it’s a thinly traded issue (averaging around 235,000 shares traded per day), it’s also a bargain stock from a growing economic zone. VLRS trades at an attractive 12 P/E ratio.

Volaris is a low-cost airline that appeals to passengers visiting friends and family and to cost-conscious business and vacation travelers. The company’s 230 daily flights connect 39 destinations in Mexico, 22 cities in the U.S. and selected points in Central America. Its fleet of 53 Airbus aircraft is the youngest in Mexico.

There are plenty of attractive stocks outside of China for investors who are interested in taking on a little more volatility. Cabot China & Emerging Markets Report has been responding to the Chinese stock market crisis by moving steadily toward a heavier cash position; the portfolio is now 50% in cash, giving us plenty of protection from the unpredictability of China.

We will continue to look for the strongest stocks in the emerging world while adjusting our exposure as necessary to avoid their volatility.

And when China comes back—and you know it will!—we will be waiting with our cache of cash and our well-stocked watch list. It will be a fun time! Click here to order.

Sincerely,

Paul Goodwin,

Chief Analyst,

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Paul Goodwin has been a researcher and writer for over 30 years. His Cabot Emerging Markets Investor will show you the vast profit potential of investing in countries whose economies are growing far faster than that of the U.S.

Cabot Wealth Advisories

Cabot Benjamin Graham Value Investor uses the methods developed by the father of value investing, Benjamin Graham, and popularized by Warren Buffet. A system that works well in all markets, it buys stocks when they're dirt cheap, and sells when they've reached full valuation, a process that takes two years for the average selection. What's important here is buying only when a stock's price is below its Maximum Buy Price, holding through thick and thin, regardless of the news or the action of the stock, and then selling when the stock reaches its Minimum Buy Price. These are great stocks to own if you're a conservative stock investor. Chief Analyst J. Royden Ward explains clearly how to build a portfolio of stocks that meet his strict requirements-plus every issue includes updated rankings on his "Top 275 Value Stocks," so you can check on other stocks you may own.

Cabot Dividend Investor focuses on preparing for retirement, recommending a solid range of income-generating stocks, preferred stocks, REITs, MLPs, closed end funds and utilities, with particular emphasis on risk, dividend safety and dividend growth. If you’re retired or thinking about retirement, this advisory is designed for you. Cabot Dividend Investor’s proprietary Individual Retirement Income System (IRIS) will help you allocate your assets for capital appreciation, current income, growth and future income investments according to your retirement goals.

Cabot Emerging Markets Investor focuses on the emerging markets economies, with special attention paid to the BRIC (Brazil, Russia, India and China) investment landscape. You'll discover the value of international diversification and the profit potential of investing in countries whose economies are growing far faster than that of the U.S. All these stocks are traded on U.S. exchanges, usually as American Depositary Receipts. Under the guidance of Chief Analyst Paul Goodwin, Cabot Emerging Markets Investor was recognized as the top investment newsletter in 2006 and 2007 by Hulbert Financial Digest, and was rated by Hulbert as one of the top investment newsletters in every five-year period 2004 to 2011.

Cabot Growth Investor is our flagship investment advisory. Published since 1970, it is recommended for all investors seeking to grow their wealth. As a subscriber, each week you'll receive clear and comprehensive updates on the stocks recommended in our legendary Model Portfolio. You’ll also be kept apprised of the status of Cabot's proprietary market timing indicators so you’ll retreat to the safety of cash in every major bear market, and you’ll be aggressively invested in the best growth stocks in every major bull market. Furthermore, you’ll learn invaluable investing lessons, so that you won’t just become a more successful investor—you’ll become a wiser investor!

Cabot Options Trader’s Chief Analyst and options expert Jacob Mintz uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can benefit from following Jacob’s advice. Whenever Jacob determines the time is right, he sends specific option buy and sell alerts via email and text-message for immediate action. He also sends out a weekly update with his views on the options market, open option positions and his outlook for the coming week.

Cabot Options Trader Pro’s Chief Analyst and options expert Jacob Mintz uses the full spectrum of option strategies to recommend the option that best suits the trade opportunity—calls, puts, spreads, straddles, iron condors and more—while always controlling risk. Whenever Jacob determines the time is right, he sends specific option buy and sell alerts via email and text-message for immediate action. He also sends out a weekly update with his views on the options market, open option positions and his outlook for the coming week.

Cabot Small-Cap Confidential is a limited-circulation advisory for investors seeking profit opportunities in high-potential small company stocks. Each month, small-cap expert and Chief Analyst Tyler Laundon features in-depth research on one outstanding small-company stock that is a pioneer in its field and undiscovered by institutional analysts. Updates on all recommended stocks are sent weekly. The circulation of Cabot Small-Cap Confidential is strictly limited because the stocks recommended are often low-priced and thinly traded. In the publication’s first five years, spanning 2007-2012, the average stock recommendation gained 30.5%.

Cabot Stock of the Week offers the very best of all Cabot stocks across the investing spectrum. Each stock is personally selected by Cabot’s President and most Senior Analyst Timothy Lutts, and guided by the collective wisdom of all the Cabot expert analysts. As a subscriber of Cabot Stock of the Week, you’ll build your wealth and reduce your risk with the single best stock each week for current market conditions among growth, momentum, emerging markets, value, dividend and small-cap stocks.

Designed for experienced investors, Cabot Top Ten Trader is your ticket to fast profits in stocks that are under accumulation now. Every Monday you’ll receive a one-page profile of each recommended stock, including fundamental analysis, technical analysis and buy ranges. Plus... each Friday, Chief Analyst Michael Cintolo will give you an update titled "Movers & Shakers," so you’ll always know his latest thoughts on these fast-moving stocks. Cabot Top Ten Trader is your best source of advice on investing in the market’s hottest stocks.

Cabot Undervalued Stocks Advisor peels back the curtain of glamour and volatility that surrounds the stock market, to assess good stock-investing opportunities without being spooked by sensationalized daily news stories. Chief Analyst Crista Huff’s goal is to assist you in outperforming the major U.S. stock market indexes, while minimizing risk by screening many hundreds of stocks for growth, value and bullish technical charts. Crista presents three portfolios: Growth, Growth & Income and Buy Low Opportunities, with specific Buy, Hold and Sell advice.

Wall Street’s Best Dividend Stocks presents the best income investments from the top Wall Street analysts, researchers and advisors. Editor Nancy Zambell scours more than 200 advisories and research reports to select the top recommendations. Dividend recommendations include high yield, growth and income, REITs, mutual funds, ETFs and more. One Spotlight Stock is featured each month, along with Nancy’s insight on the market and updates on past recommendations. One top recommendation arrives in your email box each morning, and then gets collected into an easy-to-read digest of 30 to 35 top recommendations each month.

Wall Street’s Best Investments presents the best ideas from the top Wall Street analysts, researchers and advisors. Editor Nancy Zambell scours more than 200 advisories and research reports to select the top recommendations. Investment recommendations include growth stocks, value stocks, technology, small-caps, biotech, pharmaceuticals, mutual funds, ETFs and more. One Spotlight Stock is featured each month, along with Nancy’s insight on the market and updates on past recommendations. One top recommendation arrives in your email box each morning, and then gets collected into an easy-to-read digest of 35 to 40 top recommendations each month.

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Market Update

From Cabot Small-Cap Confidential:

The S&P 600 Small Cap Index is up in 20 of the last 24 days.

The stock market has been having quite the party over the past month. Since November 8, the date of the election, the S&P 500 is up by 4.8%. Small caps have crushed that performance, rising by almost 16% over the same timeframe. Much of that outperformance can likely be attributed to a more favorable relative valuation (as compared to large cap) heading into the election. And an even better outlook coming out, given what is expected to be a pro-growth administration. Given the outlook for a pro-USA administration as well, which favors small caps over large (given their 19% ex-U.S. revenue exposure vs. roughly 30% ex-U.S. for S&P 500), we essentially wound up with a pro-small cap-squared backdrop. Everything has been working.

Alert

Many top earnings winners pulled back during the two-day Brexit selloff. I want to initiate a bullish position in Applied Materials which stood out after
blowing away earnings estimates. While I like the stock, I believe that there may be limited upside in most stocks, so I want to initiate a buy-write,
which sells expensive options.

To execute this trade, you need to:
Buy AMAT Stock,
Sell to Open the August 23 Calls.

As is always the case, you can sell one call for every 100 shares of stock you buy. Or five calls for every 500 shares you purchase.

For example, you could buy AMAT stock at 23 and sell August 23 Calls for 1.00 (the math behind this net price is 23 minus 1 equals 22).
I expect you will get a better price than I'm recommending.

The most you can make on this trade is $1.00, a yield of 4.54% in just over a month if AMAT closes above 23 on August expiration.

If AMAT is unchanged on August expiration, we will have created a yield of 4.54%.

Breakeven on this trade is 22.

The most you can lose on this trade is $2200 per buy-write if AMAT were to go to zero.

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